Where did we go wrong? Canada loses status as economic superstar: IMF

IMF warns that risks to Canada's economy are building

Canada’s economic growth will be the slowest among Group of 20 countries outside Europe as it grapples with a cooling housing market and as policy makers rein in deficits, according to the International Monetary Fund.

The Washington-based lender cut its 2013 Canadian growth forecast to 1.5%, from an October estimate of 2%, while boosting its projections for Japanese growth to 1.6%. The U.S. economy will grow at a 1.9% pace this year, while the euro area contracts by 0.3%, the fund said Tuesday in its World Economic Outlook.

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Canada’s economy is expanding at the slowest pace since 2009 as the housing boom that helped lift it from recession cools and high household-debt levels constrain demand. Canadian policy makers, who have sought to stem increases in household borrowing and cut government spending, should be prepared to take growth-supporting measures if the nation’s economy continues to weaken, the IMF said.

That could mean allowing budget deficits to widen and keeping the Bank of Canada’s policy interest rate at 1% for longer, it said.

The IMF said risks to its forecasts for Canada are “tilted to the downside,” citing concerns that the weakness in the U.S. and Europe could hurt the economy, as well as the impact of a decline in commodity prices.

“The main challenge for Canada’s policy-makers is to support growth in the short term while reducing the vulnerabilities that may arise from external shocks and domestic imbalances,” the body advises.

“Although fiscal consolidation is needed to rebuild fiscal space against future shocks, there is room to allow automatic stabilizers to operate fully if growth were to weaken further.”

The statement appears to walk the line between backing Finance Minister Jim Flaherty’s latest stand-pat budget which did not add significantly to already announced austerity measures, while also stressing that if conditions deteriorate, Ottawa should loosen economic stabilizers such as unemployment insurance and other support systems to promote growth.

The report did not mention Flaherty’s self-imposed deadline of balancing the budget by 2015, when Canada will have its next federal general election.

The IMF also has some advice for the Bank of Canada — don’t think about tightening monetary policy until the economy improves.

“The current monetary policy stance is appropriately accommodative,” it says, “and the beginning of the monetary tightening cycle should be delayed until growth strengthens again.”

Central bank governor Mark Carney has mostly withdrawn language suggesting interest rates hikes were around the corner, although the guidance still nominally points to higher rates.

That may change as early as Wednesday morning’s next interest rate announcement, however, when the bank is also expected to bring its economic growth projections — 2.0% in 2013 and 2.7% in 2014 — more in line with the IMF and the economic consensus.

Last week, seven out of nine of the C.D. Howe Institute’s unofficial monetary policy council recommended the central bank keep the policy rate at 1%. Two called for a quarter-point cut. As well, the council recommended that Carney remove the expressed bias toward raising rates and adopt a neutral stance, a signal to markets that rates likely won’t change until next year.

The IMF report sees few improvements for Canada’s economy in the next two years, with unemployment remaining near the current 7.2% level throughout, and the country’s current account balance with the rest of the world remaining in a significant deficit.

As well, the IMF no longer views Canada as the growth engine of the G7 economies. While bettering the European members, Canadian growth is projected to play second fiddle to the U.S. in 2012, 2013 and 2014. Growth in “other advanced countries” not in the G7 club, such as the Scandinavian nations and Australia and New Zealand, are also projected to outperform Canada.

Going forward, it predicts the Canadian economy will continue to be held back by high household debt levels and a cooling housing market.

“Business investment and net exports will benefit from the U.S. recovery, but high household debt and continued moderation of the housing sector will restrain domestic demand,” it says.

Globally, the IMF says economies have stabilized in advanced economies and picked up in emerging and developing nations following a slowdown in the first half of 2012. But the damage has left its mark.

It predicts the global economy will grow by 3.3% this year — 0.2% slower than its previous report in January — before improving to four% in 2014. Still, governments must keep on their guard, the IMF says.

“Old dangers remain and new risks have come to the fore,” it warns. “In this setting, policy-makers cannot afford to relax their efforts.

“The United States and Japan still need to devise and implement strong medium-term fiscal consolidation plans. The euro area needs to strengthen the economic and monetary union. In emerging markets and developing economies, some tightening of policies appears appropriate in the medium term.”

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